An employee stock option is a long-term incentive instrument being offered by a company to its employees under its ESOP plan. The employees get ownership rights in the company through ESOPs, which are later converted into the shares of the company. The company issues the options at a pre-determined price called the exercise price, which is equal to or lesser than the share's market value at the time of grant. It not only creates a sense of ownership among employees but fosters commitment and drives the company toward success and growth.

Life Cycle of ESOP Plan

ESOP plan is highly beneficial for both the company and its employees; hence it is essential for the company to carefully design and implement it adhering to legal and regulatory requirements. Companies should seek professional assistance to ensure proper implementation, and compliance adherence and to maximize the ESOP plan benefits for all the involved parties. In addition to this, they must have a clear understanding of how this plan works. The ESOPs plan life cycles include 

  • ESOP Plan Creation – This is the first step where the ESOP plan gets created by the company and a trust is established to hold the shares. Details of the plan should be clear for all to a certain level, and its eligibility criteria, contribution methods, and vesting schedules must be clearly stated.
  • Contribution – In this phase company starts making annual contributions to the ESOP trust either in the form of the company's stock or cash. It turns out to be a vital incentive for any company because contributions made in the trust are tax deductible. 
  • ‍Grant or Allocations – In this phase, the shares in the ESOP trust are allocated to eligible employees depending on the predetermined allocation formulae. The formulae are designed based on multiple factors like employee compensation, service duration, or a combination of both factors. The number of shares is different for different employees and depends on their position in the company. 
  • Vesting - The ESOPs are granted a vesting period, which is the minimum period an employee must remain with the organization to avail of this benefit. Till the vesting period is over employees cannot take the benefit out of these options. Usually vesting period depends on the years of service or the ownership is granted after some specified period.
  • Distribution – In this phase, employees receive the allocated shares at the time of certain events like retirement, disability, upon reaching a certain age, or termination. Employees have the option to either sell the allocated shares or keep them as long-term investments.
  • Valuation – This is the last step in which the value of the shares kept in the trust is periodically determined either through evaluations or independent assessments. It determines the price at which employees can sell the shares.

ESOP Plan Benefits for Employees

ESOP plan is introduced by the company to attract and retain talented employees but this plan also proves beneficial for employees in several ways. Some of the major benefits of the ESOP plan enjoyed by employees include:

  • Wealth Creation – Employees get the option of wealth creation with an ESOP plan. The stock value of the company increases with the growth of the company, and this eventually means more financial gain for the employees.
  • Sense of Ownership – With the ESOP plan employees get a sense of ownership in the company that encourages them to be more engaged and committed to the company. The employees know that the company's growth will lead to their personal financial growth.
  • Long-term Rewards - ESOPs are designed with vesting periods that motivate employees to stay longer in the company. The long-term commitment to the company leads to greater financial rewards for employees.

Recap

An ESOP plan is a powerful and effective tool designed for employee long-term engagement, loyalty, and financial benefits. Companies adopt the ESOP plan to attract and retain top talent, improve productivity, and align employee interests with the success of their business. ESOP is an integral part of modern compensation strategies. For employees, an ESOP provides an opportunity not just to earn a salary, but to invest in the future of the company they have helped to build.